Underlying Commodity

The underlying commodity is the cash commodity underlying a futures contract, forward contract, commodity or futures contract, whereby a commodity option is established and should be accepted or delivered when the option is exercised. The cash commodity is furthermore specified by the minimum quality of the delivered goods and by the delivery location.

Due to this relationship there is a high correlation between the market price of the future/forward contract and the spot market price of the underlying commodity. Deviations from the perfect correlation lead to the so-called basis risk. Indexes can have several underlying commodities, using same commodity classes, for example, grain or different commodity classes like agriculture and energy.